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Is Netflix Doomed?

For a while, Netflix seemed like the smartest tech company around. Searching for movies online was easy; mailing them back off-line was cathartic. The company constantly tweaked its red envelopes, trying to create one that you could open while tipsy and seal one-handed while late for work. Customers were treated with respect. If you sent two discs back in the same envelope, Netflix didn’t care. Employees were treated like adults. Anyone could take vacation whenever he or she wanted. The company’s attention to detail was brilliant: the company charged everyone the same monthly fee, but subscribers who watched movies obsessively had new films sent a little more slowly.

Netflix also created a pretty darn good algorithm for figuring out what movies we’d like: what titles would make us happier and less likely to switch to a competitor. When innovation on the algorithm stalled, the company created the Netflix Prize and offered a million dollars to the first team of mathematicians who could improve the recommendation engine by ten per cent. Three years later, they had a winner. Netflix was the master of all the buzzwords of the old world (customer service; supply-chain management) and all the buzzwords of the new world (crowdsourcing, the long tail), too.

More importantly, Netflix made the big decisions right. When Walmart and Blockbuster started to challenge Netflix, it lowered its prices and beat them. After extensive work, the company designed a small box that would allow you to stream movies to your TV. But then Netflix decided that selling the box would put it in the hardware business—which it didn’t want to be in—and would also force it to compete against its partners. So it spun the project off into a company called Roku. Instead, Netflix would let every hardware maker install Netflix software. Soon you could stream movies on your PlayStation, Xbox, TiVo, or just about anything else.

Now, however, Netflix looks screwed. This summer, for the first time, it wildly misread its users. It raised prices on its subscriptions, infuriating people, and then tried to separate its DVD-by-mail business into a new company called Qwikster, infuriating its customers even more. How can a company have so much data that it knows what movies people want to watch next, but not how much they want to pay? “I messed up. I owe everyone an apology,” wrote Reed Hastings on his blog.

For a brief moment, the waters calmed. But yesterday, in its earning call, Netflix announced that the past quarter was grim and that future subscriber growth will be much lower than anticipated. The stock is down fourteen per cent today and seventy per cent since the summer. In August, a share of Netflix cost sixty dollars less than a share of Apple. Now it costs four hundred and sixty dollars less.

It’s a bad time, too, for Netflix to have declining subscriber loyalty. The company believes that the mail-order-DVD business is finished, and that our DVD players are following our VCRs to the junkyard. So it is killing off that part of its business. Unfortunately, though, that’s the part with the high barriers to entry. It’s not easy for a startup to build massive warehouses and systems for mailing discs. It is easy, however, to get into the streaming business. Yesterday, for example, we learned of a startup called NimbleTV, which plans to let you watch all the channels you subscribe to through your cable provider on your phone or your tablet. If you had that, would you want Netflix, too?

Netflix fears that just distributing digital content is a mug’s game. Anyone can move bits around, which means that the price for doing so will just keep dropping. So it’s trying to create its own original content. But, so far at least, it’s not very good at doing so. “Lilyhammer,” a mobster show that Netflix introduced in January, has gotten killed by reviewers; I gave up on the first episode after fifteen minutes of mediocre acting and clumsy dialogue. Early next year, Netflix will release a new season of “Arrested Development,” which will surely be better. But the company is in an odd spot, facing the same competition problem it avoided when it spun off Roku. If its shows are bad, it’s embarrassing. If they’re good, they could irritate partners. Netflix needs content from AMC, for example. But will those negotiations get harder once Netflix is creating its own shows to compete with “Breaking Bad” and “Mad Men”?

Can Netflix pull through, or will it just continue to decline until it, and all its data, gets gobbled by Amazon? Out of a sense of loyalty to red envelopes—and to elegant algorithms—I hope the company figures out how to thrive again. But it won’t be easy for Netflix to find a way to fend off its new competitors while keeping its old partners happy. Perhaps Reed Hastings should offer another million-dollar prize … to someone who can figure out a new business model.

Photograph by Justin Sullivan/Getty Images.

Nicholas Thompson is the editor of newyorker.com, where he oversees and manages the magazine’s Web site.